The annual report from Warren Buffett’s Berkshire Hathaway presents much anticipated reading every spring. A few of the most compelling snippets follow. If you’d like to read Warren’s letter in its entirety, you can find it here. The section titled The Basic Choice for Investors and the One We Strongly Prefer starting on page 17 is the source of these notes.
Berkshire Hathaway owns dozens of companies across a variety of industries with an emphasis in insurance businesses. It also owns common stock of another dozen-plus publicly traded companies such as Coca-Cola, Wells Fargo, IBM, Johnson & Johnson, American Express and ConocoPhillips.
Buffett’s preference for equity in well-managed companies is long held and has allowed Berkshire Hathaway to outpace the S&P 500 by an annual average of more than 10.6% per year since 1965.
Buffett prefaces his commentary with a thought about the misperception of risks between stocks and bonds, particularly when considering their ability to beat inflation.
Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk.
He goes on to document his assessment of fixed income investments:
Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. …
Current (interest) rates do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label. …
Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”
Buffett’s comments are mostly reflective of the environment for U.S. government bonds and they support our current preference for using corporate bonds and foreign bonds to complete fixed income allocations in our clients’ portfolios.
The amount of money still flowing into the bond market probably confounds Buffett but what he really struggles to understand is the fascination with gold. He presents a compelling example of why gold should not be sought at such a premium.
Today the world’s gold stock (editor’s note: mined reserves, not stock as in investment security) is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A. Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.
Many of our clients have just fractional exposure to gold via broader commodities-oriented investments. We have not chosen to invest specifically in gold largely for the reasons Buffett outlines.
Regardless of whether the stock market is currently fairly valued or even overvalued after a five-month bull market, Buffett clearly prefers holding stocks rather than fixed income investments or gold.
I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.
~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA